Following the decline in the price of oil, investors may be tempted to bet on a rebound in price. In this article I will argue that both from a supply side and from the demand side conditions are not yet in place for a significant reversal of recent trends.
The supply side factors
There are four main sources of oil supply; US shale, OPEC, non-shale non-OPEC, and other sources. OPEC is by far the most resilient to low oil prices as they have the lowest operating costs. Shale can survive easily at $60/bbl due to massive improvement in the extraction of oil from shale.
The number of US rigs has is back to 2011 levels, however an increase in productivity means that output is still increasing. It is estimated that output may increase by a further 0.8 mb/d by the end of the year. Any recovery in oil prices will only lead to a re-start in shale drilling with the consequent impact on prices.
US storage capacity may be reaching a limit soon leading to pressure on oil prices. In addition, low commodity prices may lead to lower costs for shale producers. Citigroup estimates the shale well costs my drop between 20 percent and 25 percent in 2015.
Russian supplies have held despite sanctions partly because of the weaker Ruble. The weaker Ruble has helped to maintain margins for Russian operators. However, some output declines are expected as cuts to capex start to bite
OPEC supply will depend on the removal of sanctions on Iran, and political stability in other countries such as Libya, Iraq, Venezuela and Nigeria. Iran on its own can bring a significant increase of oil supply into the market.
The demand side factors
Demand has been above expectations year to date, however, gains in the energy production efficiency is reducing the dependence on oil. Countries outside the US are also experiencing a dampening of positive effects due to currency depreciation.
Oil producing countries are experiencing a significant impact on their budget due to low commodity prices. Russia, most of the Middle East and Latin America will all see subdued economic growth.
The United States is expected to provide some balance as economic conditions continue to improve. China, on the other hand, is still struggling to return to emerging market economic growth rates. Europe is showing signs of a recovery, but the Greek issue remains unsolved. Japan is in the process of restarting nuclear reactors which should reduce dependence on oil.
Automobiles are also more efficient and regulation to reduce consumption further is unlikely to be reversed.
Outlook
There is widespread consensus that the oil market is re-balancing and while supply growth will be limited going forward, demand growth will likely rebound. However, for investors timing will be the most important factor. The key factors presented above point towards further negative pricing pressure in the short to medium term. By the end of 2015 the price of oil may experience a rebound; however, this may not be enough to justify an overweight position at this stage.
Disclaimer:
This article was issued by Antoine Briffa, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri & Co. Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.